August8 , 2022

[email protected] Is No Reason To Fret; Anyone Who Bets Too Much Against It May Be Making A Mistake

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A Reuters report, quoting a “senior source” who apparently knows the Reserve Bank of India’s (RBI) “thinking”, says that the bank is willing to spend up to $100 billion to defend the rupee. This would be more than a sixth of current reserves of $580 billion, including gold.

The report is likely to be misleading or a deliberate plant intended to confuse the market about the central bank’s intentions, not a specific clue about how much of a war chest the bank is willing to expend to pursue a futile exercise.

The RBI’s officially stated position, which is the correct one, is that it will intervene to prevent undue volatility, not try to defend any particular value of the dollar-rupee exchange rate. There is no reason why it should indicate the size of its war chest now, or even that it can spend large amounts of dollars to keep the rupee stable.

The truth is, the rupee’s relative fundamentals are all in the right zone. In terms of inflation differentials, real interest rates or potential growth rates, it is far more profitable to hold rupee than dollars. The difference between the RBI repo rate and the US Fed’s target rate range is more than 3 per cent, and India’s retail inflation is at least one-and-a-half per cent lower than US inflation — a rare situation in recent decades.

Also, India is likely to grow at 7 per cent or more this fiscal, while the US is staring at a possible recession by early 2023. Bank balance-sheets in India have never been better than now over the last decade, and tax revenues continue to be buoyant as of now.

So, far from trying to sell a massive amount of dollars to hold the rupee up, the RBI would be better off expending only limited amounts of the greenback to reduce short-term volatility. And if the rupee is indeed destined to defy all sensible indicators that should inform the trajectory of the dollar exchange rate (ie, if it is going to slide beyond 80 — and fast), then the RBI should allow it to do so.

The bounce-back will be equally strong, once the market senses that the US Fed’s rate hikes have reached their apogee, possibly some time in early or mid-2023. As the Bank of England learnt the hard way in 1992, when George Soros and other currency speculators decided that the British pound would sink lower, they short-sold and ensured that it did.

The RBI does not need to find out the hard way that saving the rupee has its costs too. It is not a great idea to bet against speculators with lots of money to lose.

To be sure, even at 80 to the dollar, the rupee is looking very attractive, and over the last one week, in four of the five days from 14 to 20 July, foreign portfolio investors were buying equity in India (Rs 7,012 crore on 20 July alone), which explains some of the bullishness in the market. This does not mean the rupee will henceforth be stable, or that the foreign investors will remain invested here, but it is one point to note.

A lot depends on how much higher US interest rates have to go before the Fed starts going slow on targeting inflation and starts backing growth; as long as US rates keep rising, the RBI cannot keep rupee rates low either.

But on a relative basis, India and Indian markets are the places to be. Neither the US, nor Europe (where the Central Bank just raised rates by 0.5 per cent after 11 years), nor China (where mortgage borrowers are defaulting and some banks and realtors are tottering) are in great economic shape. India is the obvious beacon of positivity in this turbulent world, and any investor who cannot see this, is making a serious mistake.

So, my vote is for India and Indian resurgence this year and the next. The rupee may rise or fall, but India’s economy will keep rising, even if it’s at a slower rate.

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